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Value Investing

Recap: My 3 Days at #PowerMoves.NOLA 2015

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I checked in, and then got some coffee.
I checked in, and then got some coffee.

I rarely like to travel; I hate having to go through security. I hate going to conferences. Most of the time I come away feeling I did not accomplish what I set out to accomplish. On Wednesday morning I left NYC on a JetBlue flight. I was heading to New Orleans for the 2nd annual PowerMoves.NOLA conference. I had to change my plans to attend the 1st installment of the conference last year at the last minute. I am glad I was able to attend this year.

In this post I will highlight the work that PowerMoves.NOLA is doing, the startups that were at the conference as part of the program, and some of the conversations I had with founders, and other investors while I was there.

About PowerMoves.NOLA

PowerMoves.NOLA is a national initiative to deploy innovative ideas, fresh approaches, and an overall commitment to equity and diversity as a growth strategy to address the generational obstacles that prevent minority entrepreneurship. Leveraging the thriving entrepreneurial ecosystem, resources, and culture of New Orleans, PowerMoves.NOLA’s mission is to increase the number of venture-backed minority-founded companies locally and nationally.

Through its fellowship program, pitch competitions, and boot camp, PowerMoves.NOLA acts as a catalyst, providing early-stage and high-growth minority entrepreneurs with access to capital, advisors, and the support they need to succeed. The national conference events showcases some of the top minority entrepreneurs from around the country.

PowerMoves.NOLA’s objective is to make the national conference the premier event for minority entrepreneurs to support their companies, learn from experts, and build visibility of their products, and attract early stage investors.

PowerMoves.NOLA is an initiative of the New Orleans Startup Fund (NOSF), sponsored by Chevron, and in a promotional partnership with ESSENCE Festival™ presented by Coca-Cola®. ((Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.))

PowerMovesNOLA Program Book
PowerMovesNOLA Program Book

While there is danger in the venture business in getting too far away from the crowd, it can often pay to be unconventional. Don Valentine, the founder of Sequoia Capital, told me to trust my instincts, which lets you avoid getting dragged into conventional thinking and trying to please others.

In order to outperform any given market, it is mathematically true that you must not essentially *be* that market.  In other words, a venture capitalist can’t outperform other venture capitalist if they act just like them. This may seem like common sense but you would be surprised how much herding happens anyway, since many people would rather fail conventionally than succeed unconventionally.

– Tren Griffin, A Dozen Things I’ve Learned From Michael Moritz About Venture Capital. Accessed on Jul 5, 2015 at http://25iq.com/2014/06/07/a-dozen-things-ive-learned-from-michael-moritz-about-venture-capital/

Day 1 – Wednesday, July 1

The flight from JFK was shorter than I had thought it would, I did not realize New Orleans is that close. I arrived in the morning, and had a bit of time to catch up on work before activities related to the conference began.

The conference began with a networking reception and dinner at the New Orleans Museum of Art. I spent my bus ride from the hotel to the museum chatting with Rachelle Oribio who runs the Techstars++ Mayo Clinic program. Before Techstars Rachelle worked at Defy Ventures, and before that she helped convince communities in the Amazon to give up cultivating coca and instead to grow coffee and cocoa. We had a great conversation about early-stage investing, and startups. Our conversation got most animated when we were talking about startups we both got to see up-close, but in which KEC Ventures did not make an investment. It was interesting to hear what they are up to now, after going through Techstars++ Mayo Clinic and how the vision has evolved into what I assumed it would become.

I also ran into Chinedu Echeruo. He is the founder of HopStop, which was bought by Apple in 2013. We have been corresponding by email for about 3 years, but have never met or spoken on the phone. It was great to finally meet him in real life. Also, I always have a lot of fun when I meet a Nigerian or a Ghanaian . . . They get my jokes about Nigerians and Ghanaians.

Before that I had been chatting with Nnamdi and Aaron from 645 Ventures and also with Karl Bell and Adrian Ohmer from Invest Detroit. During dinner we listened to a presentation by LISNR’s Rodney William’s. LISNR is a high frequency, inaudible smart-tone technology; a new communication protocol that sends data over audio. LISNR aims to eventually be a technology standard for user authentication, peer-to-peer communication, and secure data transfer for connected devices in the evolving internet of things. I had seen him pitch in NYC about 9 months ago, so it was great to see how much progress LINR has made since then. It is in the midst of raising a Series B Round of financing.

Next time I visit New Orleans, I will try to visit the New Orleans Museum of Art again.

New Orleans Museum of Art - Jul 1, 2015
New Orleans Museum of Art – Jul 1, 2015

After dinner I went back to my room, did some work, and then went to sleep around midnight.

There’s nothing more invigorating than being deeply involved with a small company and everybody’s betting against us.

Great venture capitalists love the process of creating companies and more importantly creating customer value. Venture capital is a service business. Making others successful is the driving activity in the work.  Finding vicarious joy in the success of others is essential.

– Tren Griffin, A Dozen Things I’ve Learned From Michael Moritz About Venture Capital. Accessed on Jul 5, 2015 at http://25iq.com/2014/06/07/a-dozen-things-ive-learned-from-michael-moritz-about-venture-capital/

Day 2 – Thursday, July 2

I was up early. At 4:00 AM. So I did some work, showered, and then I emailed the attendees around 5:30 AM to say I’d be down at Starbucks between 6:00 AM and 8:45 AM, if anyone wanted to chat. The response was overwhelming. I got to chat with about 20 of the founders who were attending the conference during that time as they stopped by to chat for a few minutes each. Through out the rest of the day, and the rest of the conference founders identified me by my obnoxious neon orange sneakers, and my puma t-shirt and my black baseball cap. I got to chat with lots of people I might not have met otherwise.

#Coffee&AMeeting @PowerMovesNOLA 2015
#Coffee&AMeeting @PowerMovesNOLA 2015
My Uniform - Orange sneakers + jeans, puma t-shirt, black cap
My Uniform – Orange sneakers + jeans, puma t-shirt, black cap

Some of the people who stopped by that morning to chat; the ones with whom I had conversations that went a bit in-depth on a specific question they wanted to talk through; Edward Morgan of Revitalize Charging Solutions – he has a sales pipeline of about $8.7M and described his revenue model to me. Of course, I immediately suggested he run an experiment to see if the market will embrace another revenue model that would make his business model more attractive to investors. He currently has a payback period of two months on each device, I suggested he should see if he could reduce that to zero. I made the suggestion based on what I have learned from a startup I have been working on since August 2010, and in which KEC Ventures is an investor. I also chatted with Rudi from Joicaster, K.G from Quarrio, Craig Lewis from Visage Payroll, Larry Lawal from HealthFundIt, and Toni Okolo from PracticeGigs. I also had a long conversation with Harold Jean-Louis from SmartCoos about the market for business-to-consumer apps designed to help parents educate their young children. We spent a lot of time chatting about opportunities abroad, especially in China.

I bet the baristas and other folks at SBUX must have wondered what was going on . . . Our table was packed, some people had to pull up more chairs from other tables because the 6 at our table were taken. I’m glad I hit send on that email instead of deleting it for fear of pissing people off. There was a lot of laughter. That’s always a good sign.

Around 8:45 I walked over to Champion Square with Aaron Holiday of 645 Ventures. He was a judge for the #EntergyAngelPitch so he wanted to get there a little early.

#Entergy #AngelPitch @PowerMovesNOLA
#Entergy #AngelPitch @PowerMovesNOLA

These are the startups that pitched – 3 of the 5 are startups I had not heard about before. ((Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.))

  • bluField is an interconnected system of Bluetooth® beacon networks, which creates a high-resolution grid of a real-world geographic area.
  • FoodTrace is a powerful software platform providing food businesses with tools for next-level sourcing management. We help farmers and artisans sell more and buyers buy better. A platform built on proven solutions for businesses to locate and attract new customers, utilize data as insights and food trends for better strategy, and increase revenue with sharing tools for the value-added marketability of quality sourcing.
  • Joicaster is a video syndication platform that enables content creators to schedule, manage, and distribute live content across multiple platforms to yield larger audiences in a simpler cost effective manner. JOICASTER simplifies the process of syndicating live video to multiple online streaming platforms.
  • Lineapple turns smart phones into a mobile buzzer which in turn helps businesses increase profits by converting lost shopping time into new opportunities to increase and close sales. Lineapple is unique because it works inside the micro sales and non-revenue producing windows that are generally controlled by wait-times not during the already profitable active shopping time.
  • [N]tensify provides a branded in-app merchandise store as an additional revenue stream for mobile app developers, integrated via a software development kit (“SDK”). Ntensify creates apparel, plush, and other unique merchandise based on app designs. Ntensify provides a full service production chain, handling all customer data, payment processing, design, manufacturing, and fulfillment.

The #AngelPitch was followed by the #SeriesAPitch – 3 of the 5 are startups I had not heard about before. ((Source: PowerMoves.NOLA website. Accessed on Jul 5, 2015. Slightly edited.))

  • Maker’s Row is an online B2B marketplace that connects brands with US-based factories. Maker’s Row was founded in November 2012 and currently hosts over 75,000 brands and 6,000 US-based factories. For brands, Maker’s Row provides a transparent community for any size brand to connect with US manufacturers by viewing their factory profile and messaging directly through the Maker’s Row platform. For Factories, Maker’s Row provides a platform for factories to showcase their capabilities and generate inquiries and leads in our community of brands and designers
  • Quarrio is Conversational Analytics. Users ask questions in ordinary English and the system answers instantaneously in plain English with auto-generated graphs and charts. More importantly, the user can then ask follow-up questions and quickly drill down to the important information they seek. The software is a broad artificial intelligence platform that works with any enterprise data source, launching first to sales managers using salesforce.com. Quarrio has created a Learning Natural Language Interface to Databases delivered as a SaaS platform that enables ordinary people to do advanced reporting and analytics.
  • Upswing partners with colleges to provide an easy-to-use virtual learning center for students (for free) and a real-time comprehensive analytics for administrators. Each day, over 200,000 students have access to live, 24/7 tutoring via Upswing. Each student can choose which tutor to connect with among both their college support staff and Upswing’s coaches. Sessions take place online within Upswing. Each session is recorded, aggregated, and reported back to administrators so they can become equipped with the tools necessary to fight student attrition.
  • Partpic is an enterprise software solution that simplifies the search and purchase process of replacement parts using visual recognition technology. It’s as simple as 1. Snap 2. Discover 3. Purchase with Partpic’s API integrated on your retail website or mobile application. Partpic simplifies the part-search process by allowing a purchaser to simply snap a picture of the part she is looking to replace. Using a collection of visual recognition algorithms, Partpic matches the user-generated image with a part in our extensive database. It then returns the name of the part and its specifications. Partpic makes it easy. Consumers upload a picture of a part either via the company’s Partpic powered mobile application or the company’s website. Partpic handles identifying the part and only leaves the sales rep with the responsibility of confirming and processing the order for the consumer, eliminating purchase errors in the process.
  • Nexercise is a digital health company with the goal of disrupting the exercise industry with the only platform that provides personalized on-demand video workouts for any need to any screen anywhere. Sworkit, which is the consumer facing brand, has achieved over 1 million monthly active users with a 5X growth since January 2015 and see over 15K downloads per day. Nexercise is the first all African American leadership team to graduate from the TechStars accelerator in Chicago 2013. Sworkit is currently available on iOS and Android for both phones and tablets. They offer a “lite” version that is free and ad-supported, and a “pro” version costing a one-time fee that delivers an ad-free experience and enhanced customization. In Q2 2015, they are introducing subscriptions for both professionals and general users. Don’t quote me, but my sources tell me Sworkit hit the $100K revenue milestone for monthly revenue in June, last month.

I have been tracking Partpic since March/April 2013 when I saw Jewel pitch at NYC Seed. So I was not surprised when I heard the judge’s decision.

We had lunch after the #SeriesAPitch . . . I ate a lot – I usually do not eat very much, if at all. Shrimp and grits, more shrimp and grits, blackened pork chop with rice and beans, beef brisket sandwich, more beef brisket sandwich. I also talked with Nnamdi and Aaron about some of the startups, and possibly tag-teaming on due diligence in anticipation of their next round. I also caught up with Rudiger Ellis from Joicaster, he had come down for coffee at Starbucks early in the morning, so it was great to reconnect and chat about his experience attending the conference. It was his first time too. Danielle from Lineapple talked us into getting snowcones . . . shaved ice with syrup drizzled over it, helps cool down from the heat.

I decided to head back to my hotel room in order to make sure nothing work-related was falling through the cracks. Also, my wife decided to come down from NYC for one day, and I had not yet seen her since she arrived early that morning.

So, I did some work. Showered, and got ready for the cocktail reception that evening. It was hosted by Liberty Bank. On the bus ride over I sat next to Uchechi Kalu Jacobson of Wedocracy – before that I would never have thought I would be chatting with anyone anywhere about the logistical challenges involved in planning and having a Nigerian-American-Jewish wedding in Mexico. But, we did talk about that and it was helpful that I have been following “WeddingTech” for some time. Later that evening I met Peter, Uchechi’s husband at the cocktail party.

I went back to the hotel after the cocktail party – on the bus ride back to the hotel I got to catchup with Candace Mitchell from Techturized/Myavana who I have known since October 2014 when we met at Digital Undivided’s FOCUS100 in NYC. I told Candace about Indie dot vc when it launched. Techturized/Myavanna is in the 1st Indie.vc cohort. It was my first time seeing her since the program began and so I was eager to hear about the kinds of issues she and her co-founder are wrestling with now that fundraising is not as much of the desperate emergency it used to be.

Once at the hotel, I did some work and then went to sleep around 10:30 PM.

Day 3 – Friday, July 3

I woke up at 1:00 AM and did some work, mainly responding to emails . . . . and trying to fix appointments that had somehow fallen through the cracks because of a misunderstanding between me and Amy, my assistant. I also got caught up on news, and did a bit of reading. I emailed the #PowerMoves.NOLA attendees again, around 3:00 AM that morning. It had occurred to me that since it was Friday, and since I usually would be holding @KECVentures Investor Office Hours if were home in NYC, I ought to do the same @PowerMoves.NOLA. So I decided to hold @KECVentures Investor Office Hours @PowerMoves.NOLA, fuelled by Starbucks, from 6:00 AM – 9:00 AM. I had a large coffee with 3 shots of espresso. The barista thought I was crazy.

@KECVentures Investor Office Hours @PowerMoves.NOLA 2015, fuelled by Starbucks
@KECVentures Investor Office Hours @PowerMoves.NOLA 2015, fuelled by Starbucks

The most fascinating conversation I had during office hours was with Candace from Myavana. They are grappling with a problem that I think could form a great foundation for a ph.d thesis in combinatorial analysis – this would combine math, economics, finance, and business strategy. I suggested she chat with some of the graduate students in the Mathematics, Statistics, and Economics departments at Georgia Tech. There may be a ph.d candidate in one of those departments looking for an interesting problem to study who is also interested in this specific class of problems.

I also chatted with Sterling Smith. He and his team at Keystoke are building Sandbox, which is a system they believe will enable anyone anywhere in the world to build a mobile app to accompany an ecommerce store on the web. I expect to follow up with him when he visits NYC to try to meet investors, he’s raising a seed round.

Kofi Frimpong from Branslip also stopped by . . . I later remembered that I had read about him in 2012, and tried to connect with him then. At the time he was working on a different idea, mentoring high school students in the Philadelphia area to help them complete the journey from high school to college. Brandslip is different. It’s a social network for social media influencers and content creators.

Craig Lewis from Visage Payroll, and Samuel Lemu-Johnson from Sein Analytics also stopped by, though we could not chat for long because they were headed to an invitation only FinTech event from 8:30 AM to 10:00 AM. I was not invited to the FinTech showcase so I decided to use that time to try to catch up on some work in my hotel room between 9:00 and 10:00. That was a bad idea because I missed the bus to the next event, so I had to catch a cab. Fortunately I made it there on time.

These are the startups that pitched at the Morgan Stanley Fintech Showcase – 4 of the 5 startups that pitched are startups I had not heard about before.

  • eMoneyPool is an online community where members pool funds to borrow and save together. The concept is based on a centuries-old financial practice where your reputation within a community is your credit. Millions of people in the United States, and billions worldwide rely on money pools because they don’t have access to traditional credit, so they instead turn to each other and leverage the capital resources of a community. eMoneyPool has formalized this practice and created a high-tech solution that is efficient and familiar to our target market.
  • The municipal bond industry has grown significantly over the past 30 years, but the technology to support the industry has not kept pace. Munivestor offers financial software that tracks news, trades, and market events for more than 2 million individual municipal bonds. The information that we collect informs investors and assists them with maintaining their portfolio value.
  • Visage Payroll is a SaaS payroll startup established on the belief that small businesses shouldn’t have to pay to pay their employees or their taxes. There are 28 million small businesses in the US and 4M of those have less than 4 employees. We can help owners save an average of 10 hours/month and $1,800/year. Using back of the napkin math, that’s $50.4B in US small business savings and 280M hours a month being lost.
  • LendStreet combines credit counseling and distressed debt buying in a social lending platform to help distressed debtors proactively refinance existing debt into a low interest loan. Borrowers on our site do not receive cash; instead, the money invested by investors goes directly to paying the existing creditors at an agreed-upon discount. The discount is shared with the debtor in the form of lower debt, a reduced interest rate, and monetary incentives for financial literacy.
  • Sein Analytics helps investors, advisory firms, and issuers accurately value credit securities. Sein has developed a scalable cloud infrastructure specifically designed to manage complex mortgage and asset-backed securities (ABS).

You are the asshole who added me on LinkedIn and then did not respond to my follow up email!

– Toni Oloko, founder & ceo at PracticeGigs. PracticeGigs is in the current cohort of the MassChallenge Accelerator Program. Toni deferred starting his freshman year at Wharton in order to build PracticeGigs. We connected on LinkedIn in May. He joined me and other #PowerMoves attendees for coffee on Thursday. I responded: “I can tell we’ll get along really well.”

Time for the start of PowerUp Demo Day presented by #IberiaBank. @guydon is warming up the crowd with funny intros pic.twitter.com/JC3XsNjmZk

— PowerMovesNOLA (@PowerMovesNOLA) July 3, 2015

These are the startups that pitched at the PowerUP Demo Day, it was the culmination of the PowerUpBootcamp, which is part of PowerMovesNOLA programming. PowerUp is administered by PowerMovesNOLA in partnership with Startups Illustrated.

  • BIOEYE – puts a mass spectrometer in your smartphone.
  • Black&Sexy.TV – building the “Netflix + HBO” for the global black diaspora.
  • BrandSlip – a marketplace for social media stars to connect, collaborate, succeed and make money.
  • Callr – AI for connecting to every conference call you ever have to participate in, never dial into a conference call again. Ever. Techcrunch wrote about Callr.
  • Drivio – makes it less of a hassle for you to pay fines, and makes it easier for the government to collect fines.
  • HealthFundIt – improving the world’s collective health by connecting the people most passionate about a health condition with the scientists studying it so that people can directly support medical research in which they have a vested interest.
  • InstaSneaks – a social marketplace for the $100B+ street wear market. It enables peer-to-peer and business-to-consumer transactions.
  • Sandbox.io by Keystoke – build an ecommerce store on the web, then create a mobile version of your ecommerce store in about 10 minutes. Pay nothing, unless you actually sell stuff through the mobile app.
  • Legasyst – make interacting with the legal system as easy and seamless as using a mobile app.
  • NetworkingOut – a social networking platform that acts as a virtual athletic club for professionals.
  • Nomsy – food curation and discovery, to enable people with food allergies easily find food that suits them while on the go.
  • Paver – helps restaurants create, manage, and track their specials.
  • PracticeGigs – enables people to discover players and schedule practice sessions through a mobile social network. Initially focused on tennis in the Boston area.
  • ProSquire – a platform that enables small law firms to operate as if they have the infrastructure of their much larger peers.
  • RawShorts – a DIY builder for explainer videos, no need for a studio. If you know how to use powerpoint you know how to use RawShorts.
  • Revitalize Charging Solutions – is building a network of charging stations for electric vehicles. The charging stations also act as an advertising platform. Pilots underway with cities in Texas.
  • Roho – a media company that curates and distributes religious content. The initial product is focused on sermons for Black-American Christians.
  • RxCUE – enables patient savings through electronic medical rebates.
  • Solace – a seamless search and customization experience for home decor, initially focused on bedding, pillows, tapestries etc.
  • The Dime – makes local buying, selling, and promotion safer and more interactive with unedited video ads.
  • WedOcracy – a social wedding planning platform built by an engaged couple while they were planning their own wedding. The wedding hub of the future, today.

I spent some time chatting with Nichelle McCall, founder and ceo of BOLD Guidance. We first met at FOCUS100 in NYC, but never had a chance to chat at any length. So it was great to hear about what she’s trying to accomplish over the next 12 months. She’ll be fundraising soon. I wolfed down some lunch, and I am sure a few people must have thought I was scarfing down the food like there’s no tomorrow. I tend to eat very fast . . . I’d rather not waste time eating. I went back to the hotel and checked out. Then we headed to the Center Stage at the Ernest N. Memorial Convention Center for the #BigBreak Power Pitch – I arrived just as Dawn from Flat Out of Heels was wrapping up. These are the contestants.

  • Flat Out of Heels, LLC is the creator of the Flat Out rollable flat and the Flat Out shoe vending machine. Their rollable flats can be discretely carried for emergencies or worn all stay for stylish, durable comfort. Flat Out of Heels rollable flats are the solution to stiletto sore feet. Placed in venues like airports, nightclubs, malls, and hotels, where many women are wearing heels, the vending machines make it convenient to get emergency shoes when needed.
  • GemPhones is a fashion focused, jewelry inspired electronic accessory company that provides the most beautiful product designs in the consumer electronic industry. Every aspect of its product design is dual purpose, providing the look of a necklace and function for the usability of the device.
  • SmartCoos helps young children take advantage of their first 2,000 days and learn Mandarin, Spanish, French or English through 1:1 language sessions with a native speaker, e-books, and text nudges. Its product provides children with four critical web-based tools to learn Mandarin, Spanish, French, or English. Each child follows a tailored language curriculum based on the child’s age (0-2; 3-5; 6-8) in order to effectively use, coach, and reinforce the second language. Each child 1) Interacts with a native speaker on a weekly basis 2) Is provided with quality read-aloud eBooks 3) Learns the 200 most common words with baby sign language (“BSL”) 4) Are given daily text nudges, which increase the use of the language.
  • FashionTEQ manufactures a collection of smart jewelry for women. Its first product, Zazzi, keeps the user connected to her smartphone all day by notifying her of incoming texts, calls, emails, and more in a discreet and private display attached to a bracelet, pendant, or ring. The display provides imagery that lets the user know exactly what the notification is without having to access her phone.

I ran into Dawn Dickson, founder and ceo of Flat Out of Heels at the hotel when we went back to pick up our bags enroute to the airport. It was great to run into her since I had previously corresponded with her by email about a year ago through AngelList. We got to chat for about 10 minutes or so.

With Dawn Dickinson, ceo and founder of Flat Out of Heels, at the Hyatt Regency in NOLA after she won the #PowerMoves #BigBreak Pitch at #EssenceFest. Image Credit: Tasha Kersey Aoaeh
With Dawn Dickinson, ceo and founder of Flat Out of Heels, at the Hyatt Regency in NOLA after she won the #PowerMoves #BigBreak Pitch at #EssenceFest. Image Credit: Tasha Kersey Aoaeh

To close, for every founder who was at #PowerMoves.NOLA  and any founder who was not there, but wishes they could have been . . . This is one of the songs I listen to when I need to refuel my spirits after encountering obstacles that would otherwise knock me off my stride.

A Reexamination: Can Venture Capitalists be Value Investors?

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Let’s begin with some disclaimers. I have never actually been a value investor. I have also never made individual picks of stocks traded on the public markets. I was completely oblivious of stock markets until soon after I had graduated college in 2001. Before I arrived in the United States in 1997, I would not have been able to answer the question; What is a stock? During my 4 years of college I stayed narrowly focused on mathematics and physics, in which I completed a double major.

It was not till I began my professional career as an actuarial analyst at Watson Wyatt that I began to read the Wall Street Journal, and also to pay attention to news about the economy and the financial markets. I bought and read a copy of Roger Lowenstein’s Buffett: the Making of an American Capitalist. I bought the book because what I had read about value investing in the popular press at that time seemed made me think it was an investment philosophy that would agree with my temperament.

In business school at New York University’s Stern School of Business, I decided that I should petition the committee on academic standing to let me pursue an independent study on value investing. I drafted the petition, drew up a syllabus, won approval from the school, and then persuaded a professor to act as my course supervisor. My goal for the course was to learn enough about value investing to allow me to apply its precepts in what I hoped would be a career as a buy-side equity investment research analyst, studying publicly traded companies. That was 2008. Things did not work quite as I expected. I did not land at what one would traditionally think of as a securities analysis outfit. Honestly, for a while I did not know if I would land anywhere.

Eventually, I did land somewhere. Initially, my job required me to focus on helping two small companies navigate the treacherous economic climate that was the reality in 2008, 2009 and 2010. For two years that was all I did. Eventually, my responsibilities at work evolved. Now, I primarily spend my time assessing early stage technology-enabled startups for investment consideration by a venture capital fund that makes seed, series A and series B investments.

As you might expect, the shift in my responsibilities has led me back to thinking about value investing. I have asked myself what role it plays in my work. I have also been thinking about how I might apply its main precepts to my work. ((Any mistakes in quoting from my sources are entirely mine.))

Jeffrey Bussgang tackled this subject in a piece for Fortune in October 2010, coincidentally this was not too long after I had started my very first seed stage venture capital assignment. ((Jeffrey Bussgang, Can VCs Be Value Investors?, Fortune, October 6, 2010. Accessed at http://finance.fortune.cnn.com/2010/10/06/can-vcs-be-value-investors/ on August 10, 2013.)) I was knee deep in trying to teach myself the basics of venture capital investing. I still am. I was happy that someone else had already seen the need to tackle that question, and so I read that blog post eagerly. However, I felt a sense of intellectual dissatisfaction after I was done. So I am revisiting the question he raised. I hope I do a good job of adding to the discourse that he started. For the record, I agree with Jeff Bussgang’s conclusion – in general, it is difficult for venture capitalists to apply the concepts of value investing in a straightforward way to their work. That said, I wonder if it is not possible to apply the framework to early stage venture investing, even if the details about that application differ from what one might be accustomed to seeing or doing.

To begin the discussion I will lay out some terms that have guided how I think about this question.

When I think of a startup I prefer to use Steve Blank’s definition. According to that definition:

A startup is a temporary organization in search of a scalable, repeatable, profitable business model. ((Steve Blank and Bob Dorf, The Startup Owner’s Manual Vol. 1: The Step-by-Step Guide for Building a Great Company, California, K&S Ranch Press, 2012, page xvii.))

I paraphrase that definition very slightly. A startup is a temporary organization established for the purpose of finding the solution to a problem, and to search for a scalable, repeatable, profitable business model. It is important to emphasize the process of finding a solution to a problem because it is not unusual for venture capitalists to encounter startups that have developed a solution that is seeking a problem. I try to avoid such startups. Once the startup has found a scalable, repeatable, profitable business model it begins the process of transforming itself from a startup into a company.

Venture capitalists invest in early stage, high growth startups. Usually the startups that attract the attention of venture capitalists are going into business on the basis of some innovation; technology, business model, or even a completely new invention. Generally venture-backed startups are most concentrated in areas where science, technology, engineering and mathematics play a central role. Venture capitalists typically invest after the startup has already raise some capital from friends and family, and subsequently from angel investors. However, some venture capitalists have begun to invest exclusively in seed stage startups where often the only previous capital raised by the startup is that raised from the founding team’s family and friends. The venture capitalist provides capital in exchange for an equity stake in the startup. Therefore the venture capitalist earns a return when there is an exit – an acquisition by a larger company, or an initial public offering in which shares are sold to the investing public. Venture capitalists tend to speak of themselves as people who know how to build companies. The most sought after venture capitalists tout their prior entrepreneurial experience taking innovations from idea to startup to company, and ultimately to exit. They insist that experience makes them an invaluable source of advice and ideas for entrepreneurs traveling the entrepreneurial path. There is a debate in some quarters as to wether venture capitalists’ returns derive from their ability to pick securities much like is the case for investors in the public markets, or if instead it is in fact the company building activities of venture capitalists that lead to the returns that they have realized. ((I am greatly simplifying things for the sake of brevity, but this covers the basics.))

For a succinct description of value investing I turn to J. Dennis Jean-Jacques;

The goal of the value investor is quite simple: To buy solid businesses at exceptional prices in order to achieve adequate after-tax returns over a long period. The mental model is as follows: Good Business + Excellent Price = Adequate Return over Time ((J. Dennis Jean-Jacques, The Five Keys To Value Investing, New York, McGraw-Hill, 2002, page 2.))

One of value investing’s most important concepts is the concept of a margin of safety. To emphasize its importance in value investing Benjamin Graham says ” . . . to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY. This is the thread that runs through all the preceding discussion of investment policy – often explicitly, sometimes in a less direct fashion.” ((Benjamin Graham, The Intelligent Investor, New York, HarperCollins, the 2005 reprint of the original 1949 edition, page 241.)) Seth Klarman is considered one of the most successful practitioners of value investing. In discussing the concept of margin of safety he says: “A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world.” ((Seth Klarman, Margin of Safety: Risk-Averse Value Investing Strategies for The Thoughtful Investor, New York, HarperCollins, 1991, page 92.)) Generally, margin of safety is analyzed quantitatively – in terms of a discount to intrinsic value, remembering that value investors only buy when a stock’s market price is well below their estimate of its intrinsic value, under the assumption that they understand how the stock price will gradually recover until price approaches intrinsic value.

Another central concept in value investing is the concept of an economic moat. Warren Buffett is credited with coining the term “moat” in relation to investing after he recognized that the companies that yield the most profitable investments over long investment horizons typically possess one or more characteristics that give them a durable competitive advantage. Generally, economic moats are built through some combination of economies of scale, switching costs, network effects, and intangible assets. Some value investors speak of a soft moat as the competitive advantage that a company derives from a unique corporate culture. However one does the analysis, studying the presence and durability of economic moats involves performing a qualitative analysis that is aimed at understanding how competitive advantage may be developed, and maintained.

Consider this example of an early stage startup. ((While this specific example is entirely fictitious, it is not entirely dissimilar to many of the situations that early stage venture capitalists have to study in order to make an investment decision.)) An entrepreneur raised $200,000 in seed capital 3 years ago and formed a startup with his co-founder. Working with a small team of in-house developers as well as some contractors, they have a near-final product. The product they have developed is a software product delivered over the Web to the startup’s customers. They won a competitively-bid contract with 1 country office of a large multinational corporation that has operations in more than 200 countries, selling 3,500 different products. That contract earns the startup $50,000 a month. The contract is for 3 years. They are only 3 months in. The customer is already initiating discussions to increase the number of its employees that have access to the product. The customer also wants to act as a sponsor to introduce the startup’s product to the global corporate headquarters in a bid to make the startup’s product a part of the suite of software products made available to all 200+ country offices of the corporation. These talks are in the early stages. In addition to this, the startup is in advanced discussions with other large companies that could benefit greatly from its product. Use of its product would provide these companies with a conduit into markets that they have not yet been able to access due to resource constraints. The co-founders feel they can increase monthly revenues to $100,000 a month very soon after they obtain additional capital. So far it appears that the co-founders have done a remarkable job building the product and gaining customer traction. The startup is starting to reach the point where it needs to expand in order to keep up with demand for its product, and also to access other customer segments that it has not yet been able to pursue in a focused way. The startup is raising $2,000,000 in series A financing. It holds 1 issued patent, and has submitted non-provisional applications for 4 more. All 4 are in patent prosecution. The startup expects to raise a series B financing in 18 months after it closes the series A financing. It has no debt. The post-money valuation from the previous round is not outrageous.

Is it possible to apply the precepts of value investing to this scenario? I think so. However, to do so it is necessary to extend how one applies the traditional approach to value analysis. The difficulty here is that this startup confronts us with a situation in which there is no track record, and no clear sight of the future. ((Tobias Carlisle discusses this in a post from October 7, 2010 entitled Venture Capitalists, Value Investing and Facebook. You can find it here: http://greenbackd.com/2010/10/07/venture-capitalists-value-investing-and-facebook/)) Value investing was designed for mature companies with stock trading in the public markets. ((Value investors might be able to adapt their approach to suit mature privately held companies.)) So, how might a value-oriented venture capitalist analyze this startup?

First, I am assuming that our value-oriented early stage venture capitalist is not considering investing the full $2,000,000 that the startup needs. I am assuming that the venture capitalist will invest a minimum of $750,000 and a maximum of $1,000,000. The startup already has revenues of $50,000 per month. Assuming nothing changes, that revenue stream is locked-in for 3 years. I expect that our venture capitalist will perform some customer calls in order to assess the probability that this revenue stream will be placed at risk anytime soon. Given that the startup is already in talks with that customer to expand the scope of their relationship, I would wager a guess that the probability of that $50,000 per month revenue stream deteriorating is low. I would expect the venture capitalist to focus even more attention on the probability that on-going discussions with other customers will lead to the increase in revenues that the management team has described. Assuming a 24 month investment horizon between the completion of the series A financing and the completion of the series B financing, and assuming that the new revenues do not show up for the first 6 months after the series A financing is completed: ((Since this is a software startup we expect expenses to increase at only a fraction of the increase in revenues, so I will not focus too much on expenses.))

Total Revenues = (24)($50,000.00) + (18)($50,000.00) = $2,100,000.00

Remember our definition of a startup? One of the main sources of uncertainty that the venture capitalist faces is that the startup could run out of capital before it concludes its search for a scalable, repeatable, and profitable business model. In this case, I think our value-oriented venture capitalist can take comfort in the fact that the startup has already engaged with one customer, and is in talks with others. ((All customers are not created equal.)) Moreover, in addition to the capital that it will raise, the startup has significant revenues coming in that will help ensure it has enough cash to complete the most important tasks that lie ahead – growing its base of customers, growing its base of users, growing its revenues, finding its product & market fit, and settling on its business model. If the management team successfully completes each one of these tasks, there’s no reason to believe that the startup will have difficulty raising a series B round at a step-up in valuation.

So, the primary questions for our value-oriented venture capitalist are these: How acute is the problem that this startup is solving for its customers? What alternatives exist today? Does the startup solve the problem in a way that is fundamentally better than the way that problem is solved by the alternatives? Do the startup’s customers think so? What is the relative value of the solution that the startup has developed? Do its customers perceive its solution as high-, medium- or low-value? Does the startup have a culture of continuously observing its customers and improving the product in such a way that the product evolves as the startup’s customers evolve? Or, does it take the approach that its product does not need to evolve?

Looking at earnings ((I am using terms somewhat loosely here; technically revenues are not the same as earnings.)) in order to make an assessment about margin of safety is not something new in value investing. This is the approach Christopher H. Browne applied in his analysis of American Express after the September 11 terrorist attacks on New York City. In his own words:

Investors who realized that companies of this quality are rarely this cheap and that the income stream from the credit card business offered a margin of safety have been amply rewarded in the years since. ((Christopher H. Browne, The Little Book of Value Investing, New Jersey, John Wiley & Sons, 2007, page 68.))

Second, I expect our value oriented venture capitalist to devote some time to studying the prospect that this startup can create an economic moat around itself. To do this, I think there are at least 10 areas that the venture capitalist should study. ((I use a grid that I developed based on Bill Gurley’s post; All Revenue is Not Created Equal: Keys to the 10X Revenue Club. You will find that post here: http://abovethecrowd.com/2011/05/24/all-revenue-is-not-created-equal-the-keys-to-the-10x-revenue-club/)) For each area, I rate the startup I am studying as high, medium, or low. These are the areas:

  1. Sustainable competitive advantage; why does it exist, how long is it likely to last?
  2. Network effects; why do they exist, how long are they likely to last?
  3. Revenue; how predictable is revenue, once it is secured?
  4. Switching costs; once a customer is secured, do switching costs exist?
  5. Gross profitability; is gross profitability high, medium, or low? How does gross profitability evolve as the startup grows?
  6. Marginal profitability; is marginal profitability high, medium, or low? How does marginal profitability evolve as the startup grows?
  7. Customer concentration; how profitable is each additional customer? I prefer startups that will quickly evolve to avoid falling victim to buyer power. Many small but highly profitable customers is better than a few powerful and demanding customers.
  8. Partner dependency; is the startup dependent on its partners? What is the nature of that dependency? I prefer the startup not to be so dependent on its partners that an adverse change in the relationship proves fatal for the startup. Several startups have failed after Facebook and Twitter changed the nature of the partnership relationship they had with startups that built products on top of the traffic produced by Facebook and Twitter. ((Alyson Shontell, An Obvious Reason Why Some Startups Fail Shortly After Raising Tons Of Money, August 8, 2013: www.sfgate.com/technology/businessinsider/article/An-Obvious-Reason-Why-Some-Startups-Fail-Shortly-4717874.php))
  9. Demand creation; how much will it cost the startup to create additional demand? I prefer startups that do not need to spend large amounts of money in order to create new demand. I spend a lot of my time thinking about this.
  10. Future growth; what are the prospects for future growth? Or, how big is the opportunity that is available to the startup? Bigger is always better in this case – room for more than one player to earn an attractive returns for early investors.

This line of analysis fits well conceptually with a 3-part analysis framework for value investors that is outlined by Bruce Greenwald and Judd Kahn in their book. ((Bruce C. N. Greenwald and Judd Kahn, Value Investing: From Graham to Buffet and Beyond, New Jersey, John Wiley & Sons, paperback edition, 2001, page 35 – 47.)) The areas of analysis they highlight are asset value, earnings power value, and value of growth. For any startup asset value is none-existent, or almost nil. Allowing for variability, once the startup has found its product & market fit its ability to generate earnings should increase. Lastly, if the startup is solving an important enough problem in a big enough market, there should be enough room for future growth to earn an attractive return for our value-oriented venture capitalist.

There are numerous pitfalls to the approach I have tried to describe above. First, it is really difficult to estimate intrinsic value for an early stage startup. Second, the approach I have suggested does not change the fact that what our value oriented venture capitalist cannot possibly know far exceeds what is known in relation to the future prospects for this startup. Third, the venture capitalist must spend a considerable amount of time studying the management team of the startup in question. Building an early stage startup is an extremely daunting challenge. Much of our value-oriented venture capitalist’s ability to earn a return rests upon the management team making the right decisions at crucial periods in the startup’s life-cycle. Certain individuals, or combination of individuals, simply lack the temperament to succeed in leading an early stage startup successfully. Last, even after taking all the precautions that one can take, our value-oriented venture capitalist might still wind up making a poor investment – that is true for every value investor, but I expect the frequency of poor results to be higher for a value-oriented venture capitalist than for a traditional value investor.

I have glossed over numerous details by necessity. Fruitful implementation of a value-oriented approach to early stage venture capital investing is all about the details of each specific situation. For instance, I do not know if one can apply a value-oriented approach to startups raising capital at the seed and pre-seed stage. I think this approach only works when the startup has gained some market traction. I have not discussed how investment horizons might factor into this. I default to Warren Buffet’s view that one should invest as if one were buying an ownership stake in a company for the long-haul and not as if one is buying tradable pieces of paper.

I do not know if venture capitalists need to be able to see around corners, but I think they have to do in-depth analysis of the startups in which they invest, and I think they have to spend sometime thinking about the similarities and differences between the early stage startups that they study and the traits of the most successful public companies that were themselves early stage startups at some point in the past.

Early stage venture capitalists can apply the tenets of value investing to what they do, provided they are willing to do some extra work, and are willing to look beyond the most obvious methods that other value investors use.